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Over the past couple of years, the Brexit vote and the U.S. Presidential election results suggested that a wave of populism was sweeping Western democracies. When populist candidates failed to prevail in several European elections, some of these fears eased.

But what’s wrong with populism? In fact, populist economic policies can boost economic growth and the capital markets in the short term. Where lies the rub then? In that they can create uncertainty and volatility. Populists’ disdain for checks and balances threatens to weaken pluralist democracies and their predilection for facile solutions rarely results in sound policies. This can be bad for long-term growth.

Populists also tend to have a destabilizing effect on domestic politics. They often don’t believe in pluralism, instead portraying themselves as the only legitimate ‘voice of the people’. This causes disruption, while the arrival of political newcomers can make forming viable coalition governments more difficult, as we’ve seen in Germany, Spain, the Netherlands and elsewhere.

Several underlying trends – rising economic inequality, deepening division in values, diminishing trust and the declining appeal of mainstream parties – suggest that politics in Western democracies will remain in a state of flux. Disruptive digitalization and the role that the Internet and social media are playing in politics could further destabilize Western democracies in the years to come.

As key members of any country’s economic landscape, companies must protect themselves from risks that could arise from sudden political and legal changes. However, traditional risk mitigation models may well fall short and a new way of thinking is required.

Fresh approach

Katinka Barysch

For companies, developing a suitable approach is tricky. Even large firms find it difficult to monitor broad trends as they traditionally rely mostly on country-specific economic analysis. But basing risk analysis and forecasting on narrow economic data, without understanding the political and international context, can obscure potential threats.

Here’s an example of how broader trends can be missed: Initially, analysts attributed the rise of populism in Greece to the euro crisis, in Germany to the refugee crisis, in the United States to the decline of the Caucasian middle class, and in Austria to political cronyism. However, as populism spread across almost all Western democracies, a realization dawned that there must be common driving forces. This transnational consideration is still quite new for many, but any company with international exposure needs to monitor and understand broader, underlying trends, which can destabilize the international system and shape country-specific outcomes.

In today’s uncertain environment, it is not enough to assess the effects of economic cycles on revenue base and growth. Corporate leaders must develop the ability to better appraise the influence of political shifts on their global investments. This can help prepare for abrupt internal shocks (Brexit) or external ones (the refugee crisis) and any potential impact on their business.

The point is not to forecast every event. Politics is fiendishly difficult to predict, as shown by the fact that basically no one foresaw the Arab spring or the Ukraine conflict. Given that, it’s all the more important that decision-makers are aware of a wide range of possible scenarios: they need to identify underlying drivers, imagine different outcomes and contemplate tail-risks. Based on such scenario-building, they can hedge their bets, diversify their international investments, develop contingency plans and administer negative stress tests to make sure their assets are protected even in the worst case.

Forewarned is forearmed

They say that being forewarned is to be forearmed, but the cost of such preparation can be high. Some companies, such as Royal Dutch Shell, have an entire department devoted to scenario planning, while others turn to political risk consultancies, although their insights can be expensive and too general for the use of companies and sectors for business planning and investment purposes.

Nevertheless, in such uncertain times, the efforts needed to build up a profound understanding of potential sources of instability are well worth it. So why is the corporate sector often slow to act?

After the end of the Cold War, the world enjoyed a long period of extraordinary political stability, both globally and in domestic politics. Looking at underlying trends, this period seems to be over. And yet, many investors and business leaders struggle to adjust mentally. The consistency of the past makes it difficult to realize how profoundly the world has changed. Expectations that things will return to ‘normal,’ in terms of stable democracies and an open, globalized economy, are unlikely to be met.

When the world is in a state of flux, long-term investments become more difficult – one reason why Western companies sit on trillions in cash. But that entails the risk of missing opportunities. Disruptions in established structures do not have only downsides. The changes we see in Western democracies, for example, can sometimes lead to populism, but they can also lead to an election victory for reformist newcomers like Emmanuel Macron.

Businesses must adapt to this new environment of increased political uncertainty. They must stay alert and constantly observe the global situation. This will require more investment in political risk analysis and management.

Katinka Barysch is Director of Political Relations in the research department of Allianz SE and a German economist and commentator. She holds a Bachelor of Arts degree in Political Science, Economics and Law from the Ludwig Maximilian University in Munich and a Master of Science in International Political Economy from the London School of Economics.

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